WHY DOES THE MARKET KEEP GOING UP?
This is a question that confounds those on the sidelines and aggravates the bears to no end. Many attribute it to some sort of bank or government engineered conspiracy theory. Others say it is simply performance chasing by large money managers. Personally, I find the answer in the psychological. When you break market transactions down to their simplest point it really all comes down to psychology. The transaction price point occurs at an agreed upon price where one party succumbs to the demands of the other (to oversimplify things). In other words, one party has a greater need to achieve a certain price on the buy side or sell side. This is all due to psychology.
This was best seen during the last year. 12 months ago sellers were desperate to get out of stocks. The buyers were in an obvious position of power where they could actually drop their bids or hold out altogether. Today’s market environment is very much the opposite. The sellers are in a position of power because there is no great need to sell. The buyers on the other hand, are in a position of fear caused by the idea that they might miss out on future price appreciation. There is no dire reason to sell therefore the buyers simply overpower the sellers on a daily basis and this drives prices higher.
This is all being compounded by the fact that we are coming off such a massive psychological imbalance earlier this year. This is classic overshooting in a mean reversion process. The following image represents price action around the business cycle. The blue line represents the mean. As the economy expands investors tend to overshoot to the upside. The inverse occurs in a recession. What we saw in March was a classic case of panic fear that resulted in a massive overshoot to the downside. My March 8th bottom call had very little to do with changing fundamentals and everything to do with a panic overshoot. Admittedly, the timing was remarkably lucky, but the approach was not. I was simply playing off the idea that stocks and emotions had overshot far too much to the downside.
So where do we sit today? Today’s market is characterized by a lack of negative psychological catalysts that can change the current market dynamic where buyers overpower sellers. That means we are likely to continue seeing the buyers overpower the sellers until a negative catalyst catches hold of the sellers in the market and instills enough fear to grab the reins backs from the buyers. Until that occurs, psychology is likely to remain positive (but not yet euphoric) and price action will likely follow.
Nice take on the topic. Couple of typos:
2nd para, last line: “There is no dire reason to sell therefore the [sellers] simply overpower the [buyers] on a daily basis.”
Last para: “That means we are likely to continue seeing the [sellers] overpower the [buyers] until a negative catalyst catches hold of the sellers in the market and instills enough fear [for the buyers] to grab the reins backs from the [sellers].”
TPC Response – Those aren’t typos. I think you’re reading it incorrectly or misinterpreting it.
Please update us when you see the catalyst. Also has Goldman revised their forecast and please let us know. Thanks.
You state: “. . . one party has a greater need to achieve a certain price on the buy side or sell side. This is all due to psychology.”
But this begs the question: what explains the psychology.
The shortcoming of attributing the movement of the market one way or the other solely to psychology fails to identify what materially is the basis for the psychology itself.
There are material reasons that explain the massive swing one way or the other. By material I mean something of weight, of substance, that supports the thinking, sentiment, and psychological persuasion.
There is no doubt that understanding the general and prevailing psychology is crucial in comprehending what is taking place in the market. But unless tied to substantive arguments it lack tangibility.
When psychology isn’t tied to a material basis, what we like to call fundamentals, then said psychology can very easily reverse course, not so much because the fundamentals have changed but because the perception has. And why the reversal in perception? Here lies the catalyst. This is important in understanding when attempting to identify the potential catalyst that reverses the trend. When the psychology is based on less than substantive basis, then the psychology is fragile and can easily reverse.
In our current condition, the dramatic move up in the stock market is explained by the support from the Fed’s QE program. It is this that has provided the added fuel (read cash), that has propelled the market. But for this to succeed, the psychology of hope and recovery must also prevail. Only together can they succeed. There is nothing conspiratorial about this.
The turn will come when the perception of recovery withers (which will only come if and when evidence clearly points in that direction), along the withdrawal/end of QE sets in. This explains the degree to which there exists a debate over whether what is taking place is a bona fide recovery or not. If the recovery were beyond a doubt, then so is the perception. That is not the case today.
To the degree that the Fed withdraws “liquidity”, to that degree the perception of recovery will be found to walk on its own two legs or not.
Marc Faber on Tech Ticker, there are several other Faber interviews as well:
http://finance.yahoo.com/tech-ticker/article/338847/Faber-Emerging-Market-Economies-Will-Challenge-and-Surpass-the-West?tickers=fxi,spy,pin,dia,eem,msf
The dollar carry trade:
http://www.ritholtz.com/blog/2009/09/the-dollars-role-in-rising-risk-appetites/
Got to disagree with you there TPC. 10% of market volume is in BAC. 60% is run by machines.
Unless you think that it is in the machines’ programmer’s psychology.
This market is ridiculous. Perhaps there is a government put at 800 snp, I think there may be.
We’ll see if psychology continues to pile on, but the idea that we are through the worst is laughable.
The only question you have to ask yourself is if balance sheets matter.
I believe they do. Going long at this piont is picking up fractions of a penny in front of a steamroller. And if inflation does carry us to snp 2000 then will it matter anyway?? as we are all screwed by such an event.
stock price is driven by supply and demand is the biggest lie out there, there is never a seller and buyer, there is only banks vs everyone else, big money vs small money, master vs the slave.
If in doubt see where the profits are booked:
First quarter, that is in a downwards slope for equities :
Banks trading derivatives desk made 1042 billion usd profits
http://www.occ.treas.gov/ftp/release/2009-72a.pdf
Sorry but Bernanke and co never pleaded for morality,neither for a better educated financial world as it may hurt your profit lines.
A mere repeat of Greenspan era.
I don’t doubt that computers play a greater role in every day trading, but computers didn’t make the market crash last year. The trading in the last year is an obvious sign that psychology still rules markets….
As for what drives the psychology – fear and greed based on future price expectations. I know a lot of investors don’t like to admit it, but things are getting better even though they’re attributable mainly to the government printing press.
If one is in the nano science i agree things look better
http://research.stlouisfed.org/recession/indicators.html
With the increased savings rate, assets have to be purchased. Everyone is fearful not because of greed, but because of loss of purchasing power. Through all the housing booms we have experienced, how many of you (and your friends) have struggled with the question of buying before being priced out. This is what the Fed wants you to think, to create an inflation expectation, without actually creating inflation. Logically, it is the right move to buy on this psychology … but when inflation really starts to creep in then the Fed will turn on you. They did this in summer 08 to the short financial/long oil trade. This time, I think Obama’s friendliness with unions could be the turning point. Watch what happens in Calif. … for now keep buying … be happy!
TPC:
With all due respect, fear and greed are psychology, so saying that they drive the psychology is circular reasoning.
Seems to me most investors recognize the improvement in the economy, but it is a matter of degrees; to what extent is this improvement indicating a sustainable recovery and to what extent is it merely a temporary bounce? Granted, government is substituting for lack of household re-leveraging to compensate for “jobless recovery”. The question is how sustainable this will be and, if the impact is insufficient, whether a second stimulus is politically feasible, and if so whether it would be effectual since the impact is far down the pipeline.
In any case, what is driving the stock market isn’t so much investors, in my opinion, but speculators, who are embolden by Fed QE and government backstopping the financial sector. Now the FDIC is considering getting a loan from the mega-banks to expand its reserves, for purposes of protecting depositors from bank failures. If this isn’t a circle jerk, I don’t know what is.
If and when the disconnect between credit markets and real economy of foreclosures, consumer defaults, weak growth and earnings emerge, then things will get interesting.
Don,
It’s all perception of the current market environment. It’s a chicken and egg question. Do the fundamentals drive market price and psychology or vice versa?
Personally, I think psychology is generally the leading indicator of future price action, but that’s entirely up for debate. I doubt most people agree.
It keeps grinding higher, buy the dips.
Because its a bullshit market manipulated by FU Capitalists!
after FOMC..it went up to 1076, then take a plunge of 20 points…world of pain..Look at the volume of selling…tell me that this crap isn’t manipulated.
I am just curious as to what things are getting better? We are “muddling through” I suppose, but the damage being done right now is even more dangerous than what the banks did.
I think we continue to whistle past the graveyard. Do we make it, I hope so for everyone’s sake.
But I remain very very concerned when fundamental problems are not addressed.
And to answer your earlier point, yes, when the market was dropping it was on heavy volume and yes, it was real, honest to goodness selling.
For this “rally” draw a line on volume and price rise over the last six months and I think you’re going to see an interesting story.
Bosun,
Capitalism was intended to function in a free market. Not one which is manipulated by a central bank for political reasons.
The recent turmoil is not a fault of capitalism but the politicians and central bankers who take advantage of it.
I feel bad for the people who bought the markets at the highs today only to see it reverse in 20 minutes. Nobody said gambling was a sure thing…
TPC,
I agree with Don and several others on this one. Mish has said the same thing. The fuel that has fired this market is QE by the Fed. Without that money there would be no upward movement, which then fuels your psychology. But Mish has shown that the majority of the money coming into this run has been from the government.
I agree with P11, what is getting better? and then I see this:
http://www.businesscycle.com/news/press/1567/
when is his WLI going to at least flatten out; maybe when the mainstream econ data data gets ‘main street’ better, the AAII #s will climb above 50% bulls and we will have a meaningful correction, today was our 6th neg reversal since early Aug.
I think it’s impossible to make a sound argument that the economy hasn’t improved at all. Just look at the rebound in GDP, ISM, leading indicators, etc etc. Don’t get me wrong, I don’t think things are all bright and rosy. I still firmly believe the long-term structural problems are very much with us, but we’ve come a long way from ISM at 35 and GDP at -6%. There’s just no denying that.
My psychology tells me bonds yields are not competitive with stocks — and if what I read is correct, that the bond market is 5 x as large as the stock market, then it figures. Besides, with the dollar down I wouldn’t be surprised if foreign capital is about to buy a piece of America. The Chinese certainly could.
Here’s what I know because it’s what I see when I look around where I live.
People are spending less money; they are being frugal with it, making hard choices about what to buy based on need versus want.
Vacancies are showing up with greater numbers when I look at the various strip malls near where I live.
People are worried about their jobs; some have lost theirs and indicate problems with finding new ones. I don’t know anyone who has filed for unemployment, however.
I feel a permeation of caution bordering on dismay from people with whom I interact on a daily basis; there is a lot of worry.
If psychology is the driving factor behind The Miracle Rally of 2009, I certainly don’t see that hope, optimism, and confidence around me from the people at large. What I see and feel is contrary to the action in the markets, which has caused the confusion to me, at least until recently.
I tend to agree with others here that QE is at the root of all this. That, and the confidence in the government to bail out companies that are too big to fail. But that is all institutionally driven, and that makes sense given how money that is printed makes it into the economy – as deposits into Reserve Bank Members, which are used to make loans or investments.
Until the trenches (the streets where I live) begin to reflect the apparent “physchology” of the market, I’m not buying it – it just doesn’t feel right. That doesn’t mean, however, that we can’t ride the wave to benefit ourselves. I do, but I also have stop losses in place known only to myself to ensure I won’t be crushed when QE stops being effective; it certainly can’t sustain the markets forever.
The rally since March occurred because Bernanke and friends “loaned” enough new money to their friends to allow them to keep buying up stock of the zombie banks, to generate a prolonged short squeeze. Normally, when there are that many people shorting a stock, the inflation of the number of shares caused by all of the short sellers “borrowing” the real shares and selling them (without even the 10% reserve limit of the fractional reserve banking system, so far as I can see), usually drives the price of the shares down, as the total number of buyers chases an ever increasing number of “new” shares (“newly created” through “borrowing” by brokers who apparently have no contractual obligation to make the owners whole, such that any way you explain that transaction you end up with at least two people having an unencumbered claim to the same shares). Those with a vested interest in keeping those zombie banks from failing (the aforementioned Bernanke and friends) prevented that result in this case and manufactured a short squeeze by using newly created money to buy up all of the newly created shares. So here you have a case of monetary inflation, allowed by a fractional reserve banking system, winning out over stock inflation, allowed by a fractional reserve (or equivalent) stock market. And we are in this whole mess due to legalized counterfeiting (of money in the fractional reserve banking system and of shares in the short selling market). And the only way to fully restore a sound, honest and free currency and an honest, free and rational market is to completely abandon both of those flawed systems.
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